Australian dollar follows commodity prices

Yes Warren. I agree. Australia has a 'lazy balance sheet' (the title of my last article on the subject). This is the time to borrow more - at current ultra low rates - to finance visionary productive projects.
Cheers, Ashley

I've also studied Australia's foreign debt over many years, including playing a part as a junior Treasury officer in writing the first Treasury RoundUp article on the topic in 1983.

It seems that every few years, or when some round number level of foreign debt is reached, there's another round of hysteria about the subject. EG the Macquarie Bank paper in the late 1980's comparing the Australian economy to a boiling frog because we were allowing foreign debt to get out of hand.

The $1 trillion level was first highlighted in the media early this year with the usual sensationalist headlines.

In case anyone hasn't noticed, Australia hasn't boiled like the hapless frog we were compared to a quarter of a century ago. Nor have any of the other disasters befallen us that the foreign debt doomsayers have trotted out on a regular basis over the intervening period.

Instead, foreigners have continued to help finance our development, including the expansion of our mining export capacity (commonly called the mining boom), the continued growth of our housing stock, the expansion of our services sector, the early days of the expansion of our infrastructure (at long last) etc. Recently, they've funded things like the fiscal policy that helped us to avoid a deep post-GFC recession as sovereign wealth funds have happily invested in Australian Government bonds.

The fact that our foreign debt is nearly $1 trillion is a sign of the confidence that the rest of the world has in our basic economic structures and outlook. That story is, of course, not much of a headline so you won't read that in the tabloids.

Another fact to keep in mind: the vast majority of that foreign debt is in A$. Some of the concerns 25 years ago were based on us having borrowed in foreign currencies and therefore we were more exposed to servicing costs blowing out if the A$ collapsed. That isn't much of a problem now - the foreign lenders have taken the currency risk by investing in our dollar, too.

Finally, no one ever points out that our net foreign equity position has been increasing too - in this case, we are the investors in foreign assets. So to some extent the net foreign debt has funded our investments in global markets. How is that a bad thing?

So to borrow a phrase the RBA Governor recently used in a different context, perhaps we should just chill out about foreign debt. Or at least understand the full picture of what it is and what it means before getting worried just because some seemingly large number gets bandied about in the press.

Hi Richard
re - Australia's net foreign debt.
I have studied Australia's debt position in depth over many years and one thing I have found is that the numbers are very rubbery (even the 'official' numbers) and numbers bandied about by politicians are the rubberiest of all. Never believe anything a politician says - especially when their mouth is open.

The current level of government debt is relatively low, but is rapidly getting to be serious if the government doesn't rake radical action quickly.
I wrote about our debt situation earlier this year - see
http://cuffelinks.com.au/australias-government-debt-position-lazy-balance-sheet/

Corporate (non-bank) debt levels are quite modest. The bulk of the foreign debt problem is in household debt, most of which is held via the banks and mortgage securitisers. Government could bring house prices down by ending the CGT exemption and negative gearing but they won't because they will lose millions of votes. Bank regulators hopefully will reduce credit growth by fixing the silly advantageous capital rules for housing lending and lowering bank gearing generally, but the impacts will be slow.

The impact of trade agreements on debt levels is far too complex for comment here. Let's just wait and see if the recent Pacific trade agreement is actually endorsed and implemented by all the signatory countries. Even if it is, it will only make trade partially free-er on some things - it is certainly not a general FTA. I don't have high expectations - there are too many votes at risk in protected industries.


cheers

ashley

hi George,
re the recent rises in the AUD while commodities prices are falling - Like anything else the price of an item is determined by the balance between supply and demand. The price of the AUD (exchange rate with another currency) is determined by the volume of buyers and sellers on any given day.
Because Australia has relatively high interest rates, there is great demand from foreigners to borrow in their local currencies and invest the money in AUD assets like cash (T-bills, bank bills), bonds, real estate, etc at much higher yields they can get at home. To do this they must sell their own currency and buy AUD currency, which pushes down their currency and pushes up the AUD.
We saw this in November after Mario Draghi hinted at lower rates and more QE in Europe because of deflation and economic stagnation there. The Euro fell and the AUD rose as global investors sold Euros in anticipation of Euro rates falling further, and bought AUD to get our 2% cash rates, especially when the RBA took further rate cuts off the table at the November RBA meeting.

This is called the "carry trade" and it is speculation because it is an un-hedged bet on the AUD remaining where it is. or at least not falling for the time being. It works for a while and the foreign speculators make the extra interest yield on Australian assets, but it always snaps back and the slow speculators lose big time when the AUD falls (the quick ones get out early).

This explains many of the short term upward spikes in the AUD while on its long term decline.
The long term structural weakness of the AUD is due to our higher inflation (inflation and currency decline are merely two sides of exactly the same coin - the declining real purchasing power of the currency). It is our higher inflation rate that is the reason for our higher domestic interest rates, but speculators see it as a short term opportunity to make quick money if they can get in and out quickly enough before the next fall.

cheers
ashley

I've read that Australian net foreign debt will hit $1 trillion come Xmas, up from $180bn when John Howard won the 1996 election. I am wondering whether it's time to revisit the history of Australia's foreign debt, public and private, and include the impacts government actions, of free trade agreements (FTAs) and the closure of industries due to the of removal of protections, assistance and subsidies. It seems to me that as industries close we spend more on foreign goods and our foreign debt increases. Senator Nick Xenophon has provided some data to show the negative impacts of previous FTAs. I remember the days of Paul Keating speaking in the 80's about the J curve and and the 'beautiful trend upwards' that was about to appear. I don't think I've seen it yet.

I am at a loss to explain the recent spike in the A$ as commodities become even weaker? Is it just a blip in a longer term downward trend?